Taxation and Liquidity
Listokin, Yair, The Yale Law Journal
ARTICLE CONTENTS INTRODUCTION I. ASSET PRICES AND LIQUIDITY A. The Theoretical Basis for a Tradeoff Between Returns and Liquidity 1. Illiquidity Premium in Absolute Returns but Not in Residual Returns 2. Illiquidity Premium in Absolute and Residual Returns B. Supply and Demand in the Market for Liquidity C. Empirical Evidence for the Relationship Between Illiquidity and Return 1. Cross-Sectional Evidence 2. The Value of Liquidity in Nearly Identical Assets a. Restricted Stock b. Treasury Bills Versus Treasury Notes D. The Importance of Liquidity in the Economy II. THE PRICE AND QUANTITY OF LIQUIDITY IN THE PRESENCE OF INCOME TAXES A. The Impact of Income Taxes on the Illiquidity Premium when Investors Are Risk-Neutral 1. The Illiquidity Premium Changes when Income Taxes Are Introduced 2. Income Taxation and the Price and Quantity of Liquidity B. The Impact of Income Taxes on the Illiquidity Premium when Investors Are Risk-Averse and Illiquidity Costs Are Correlated with Aggregate Risk 1. Illiquidity Supply and Demand with Fully Deductible Illiquidity Costs and Fully Adjustable Investment Portfolios--Domar-Musgrave for Illiquidity 2. Illiquidity Holdings with Partially Deductible Illiquidity Costs 3. Illiquidity Holdings with Partially Deductible Illiquidity Costs, Costly Portfolio Rebalancing, and Late-Arriving Income Tax Refunds for Illiquidity Costs III. INEFFICIENCIES CAUSED BY THE TAXATION OF ABSOLUTE RETURN AND THE PARTIAL NONTAXATION OF LIQUIDITY A. The Size of the Financial Sector 1. Overproduction of Nontaxable Banking Services Rather than Interest 2. Securitization a. The Benefits of Securitization b. The Costs of Securitization c. Amounts of Securitization and Taxation 3. Public Equity Trading a. The Benefits of Public Trading b. Costs of Becoming a Publicly Traded Company c. Publicly Traded Companies and Taxation 4. The Size of the Financial Sector and the Production of Liquidity B. Clientele Effects and the Nontaxation of Liquidity 1. Tax Status as a Determinant of Liquidity Holdings 2. Why Do University Endowments Hold Illiquid Assets? Tax Motivations in Addition to "Long-Term Horizons" IV. THE TAX STATUS OF ILLIOUIDITY IN BROADER PERSPECTIVE: INCOME TAX FEATURES BENEFITING ILLIOUIDITY AND OTHER "SOLUTIONS" TO THE TAX ASYMMETRY BENEFITING LIQUIDITY A. The Role of Existing Income Tax Features in Increasing or Reducing the Distortions in the Market for Liquidity 1. The Realization Requirement and Preferential Capital Gains Rates 2. Corporate Taxation B. Deductions for Illiquidity Costs C. Taxing Imputed Income from Liquidity 1. Imputation of Income from Liquidity 2. A Wealth Tax as a Tax on the Imputed Income from Liquidity 3. Other Ex Ante Income Taxes as Solutions to the Asymmetric Taxation of Liquidity and Illiquidity CONCLUSION
Asset returns depend upon the liquidity of a security. (1) Cash, for example, yields no financial return, but investors are nevertheless willing to hold cash as part of their portfolios. Cash provides transaction services, enabling investors to consume quickly and easily. The connection between liquidity and asset returns demonstrates that the standard model in which asset returns are determined by a tradeoff between risk and return is, at best, incomplete. Indeed, the liquidity/return tradeoff provides a better explanation …
Questia, a part of Gale, Cengage Learning. www.questia.com
Publication information: Article title: Taxation and Liquidity. Contributors: Listokin, Yair - Author. Journal title: The Yale Law Journal. Volume: 120. Issue: 7 Publication date: May 2011. Page number: 1682+. © 2009 Yale University, School of Law. COPYRIGHT 2011 Gale Group.